Financial instruments

Question 1

What requirements must be met for a derivative to be qualified as a fair value hedge?

Answer 1

1. Formal documentation between derivative/hedged item
2. Expected to be highly effective in offsetting changed, assessed every 3 months.
3. The hedged item is specifically identified.
4. Hedged item presents exposure to changes in FV that could affect income.

Question 2

Futures contracts (gain or loss)

Answer 2

Any gain or loss on futures contracts not designated as a hedge is recongized in net income, use the futures rate.

Question 3

Where is the fair value of financial instruments located?

Answer 3

Body of financial statements

           Or

Footnotes to financial statements

Question 4

Financial disclosures (credit risk, market risk) Which is required?

Answer 4

The concentration of credit risk is required to be disclosed. (For all financial instruments).

        -Disclose in notes to financial statements.

The market risk is encouraged but not required.

Question 5

Disclosed for most financial instruments (value?)

Answer 5

Carrying value and Fair value.

Question 6

In order for a financial instrument to be a derivative for accounting purposes, what must occur?

Answer 6

It must have one or more underlying’s.

It DOES NOT require an initial net investment.

Question 7

Determination of the value or settlement of a derivative calculation?

Answer 7

An underlying and a notional amount.

Question 8

Derivative designated and qualified as Fair value hedge. G/L Recognized where?

Answer 8

In current net income

Question 9

Qualified derivatives may be used to hedge the cash flow with what?

Answer 9

An asset, liability, or forecasted transaction (but not a form commitment )

Question 10

Perfect Hedge

Answer 10

No possibility of a future gain or loss. It exactly offsets.

Question 11

Fair Value hedge vs. Cash flow hedge (recognition)

Answer 11

Fair Value hedges gain/losses are in I/S.

Cash flow hedges (when effective) are in OCI, when ineffective, in I/S.

Question 12

Fair value option, net income.

Answer 12

Income is calculated as the amount of dividend received PLUS the appreciation of the investment for the year.

Question 13

Primary risks associated with financial derivatives

Answer 13

Liquidity

Credit risk

Market risk

Question 14

Derivative instruments (notional amounts)

Answer 14

Forward contracts are negotiated privately between two parties without a clearinghouse, so the notional amounts and settlement dates are not standardized as they are in a futures contract.

Question 15

Derivative Disclosures required

Answer 15

Description and strategy of entity’s objectives for holding derivatives

Information on the volume of the company’s derivative activity

The location and amount of the G/L reported on I/S and OCI and net gain or losses for them.

Question 16

Call option

Answer 16

Gives the buyer the right but not the obligation to purchase the underlying asset at a strike price.

Question 17

Which derivative has the least credit risk?

Answer 17

Futures contract as it is guaranteed through a clearinghouse.

Question 18

Call options

Answer 18

A zero-sum game in the end.

Question 19

Effective cash hedged (income statement impact)

Answer 19

The effective portion of a cash flow hedge will remain in OCI until the company begins to depreciate the asset. At the time the asset is purchased, there is no deprecation and any fair value changes will not impact net income.